After the last few weeks of geopolitical volatility spilling over to the financial and crypto markets, it seems like all anyone can talk about is what startups and VCs can, should or will do in the anticipated downturn.
As an investor who prides himself on being able to identify the best early-stage startups, I’m confident that VCs with high-quality seed investments don’t need to fear a potential slowdown. Obviously, a slowdown would result in lower valuations and less capital flowing to startups, but that might not be the worst thing for investors looking to double down on their investments at attractive prices.
The capital markets are still very much on the side of founders, and there’s plenty of room for the scales to rebalance. VCs should be excited about the coming buying opportunities.
Startups slowed spending during the pandemic and extended their runways. At the same time, they’ve been able to raise big rounds at increasing frequencies. Startups that managed their finances wisely now can boast a strong balance sheet, lower expenses and plenty of cash.
Seed-stage investing is the best place for venture capital to deploy when global uncertainty sprouts up.
What this means for VCs is that if the financial markets slow down, valuations on these strong companies with long runways come down, allowing investors to increase their share of the cap tables of their favorite portfolio companies at a discount.
If you look at the 2008 financial crisis, early- and late-stage startup funding crashed, but seed funding exploded, giving rise to some of the biggest companies we see listed on stock exchanges today. This growth in seed funding was led by emerging technologies like mobile and cloud.
Today, similar opportunities exist in SaaS and web3. It took many years for early- and late-stage funding to rebound to 2007 levels, but during that window, the amount of capital pouring into seed rounds simply continued to rise.
Investors became leery of writing huge checks to companies that required massive growth and scale to continue growing into their valuations. The risk/reward simply didn’t balance out. On the other hand, seed-stage companies faced much more reasonable scaling challenges to reach growth milestones.
The risk/reward just made sense. Investors can’t just sit on capital; they have to invest somewhere, and when downturns happen, the economics shift to deeply favor younger companies.
So what can we learn from history? As investors grow cautious, we’ve seen increased attention (and capital flows) into pre/seed startups, even from those who traditionally invest in early- and late-stage companies.
The shift has already begun, and history is starting to repeat itself. SaaS and web3 are now on a path that’s not very different from the one mobile and cloud technologies took to get to the forefront in the 2000s.
NFTs are turning users into members, and SaaS startups are turning legacy industries into digitally integrated behemoths capable of enormous margin expansion. We are still in the early days of this transformation, so even as world markets tremble over macroeconomic and geopolitical factors, companies building in the SaaS and web3 space have plenty of achievable growth on the horizon, as well as the capital needed to get there.
With rocketing valuations, startups have been taking on cash to not just continue their growth, but insure it against the kinds of investment pull-backs we’ve been seeing at the late stage. The truth is, founders, investors and everyone in between have been calling tops on the market for more than a decade now. In fact, startups were preparing for a potential recession even before the pandemic hit.
The past couple of years, with the pandemic, rising inflation, supply chain constraints and now the Ukrainian invasion, have shown founders — and the world — how quickly things can change. Savvy founders have adjusted their strategies accordingly and have positioned their young companies with the infrastructure and capital required to maintain growth through global uncertainty.
Let’s take seed-level enterprise SaaS startups as an example. The pandemic has made strong digital offerings and tools essential parts of every business. This contributed to the rise in valuations of these startups as companies of all kinds flocked to digital products to manage everything from remote payrolls to HR, analytics, conference calls and more.
As inflation began creeping up, the Ukraine invasion, sanctions, supply chain issues and market volatility have caused valuations to take a very attractive dip.
All of this has happened while ARR/LTV remains strong, and the market demand for these tools shows little sign of weakening. In short, investors can get exposure to great companies at a discount.
This isn’t all sunshine and rainbows for investors, though. Companies will fail due to these global factors, especially if the slowdown drags on. That said, there are many strong startups with impeccable balance sheets that are extremely well suited to manage (and even thrive) during these volatile times.
Investors are concerned about deploying more capital in this climate, but I’m afraid that’s a short-sighted perspective that history has proven wrong. Venture investing, in particular, is a long game, and the current dynamics present a uniquely rare moment for investors to increase their exposure to young companies that will win in the long run.
We are currently watching this dynamic repeat itself as investors begin moving away from late-stage companies in favor of writing checks for early-stage startups.
If you’ve been following history, it’s clear that seed-stage investing is the best place for venture capital to deploy when global uncertainty sprouts up.